Split amongst circuits regarding good faith defense to a discharge injunction violation may be heard by the Supreme Court

A Chapter 7 debtor who receives a discharge of debts is protected by what is known as the discharge injunction. The discharge injunction provides the debtor with a fresh start, which is the principal purpose of the Bankruptcy Code. The discharge operates as an injunction by a creditor against the commencement of continuation to collect, recover or offset any debt as a personal liability of the debtor¹. A creditor’s violation of this section can be subject to imposition of monetary penalties, including payment of actual and punitive damages.

There are debts that may be deemed nondischargeable, as governed by Title 11 of the United States Code². However, to fall within this rubric, the court must make a specific finding. Creditors may operate under an incorrect presumption their debt has not been discharged under the pertinent provisions of the statute and undertake steps to collect their debt without first seeking a declaratory ruling from the court.

Such was the case in a first circuit decision in Internal Revenue Service v. William Charles Murphy where the bankruptcy court ruled that the Internal Revenue Service (IRS) violated the discharge injunction when its employee took deliberate steps to collect on a debt. Even though it had alleged a good faith belief that the debt was not discharged, the collection actions of the IRS employee did violate the discharge injunction.

This decision is diametrically opposed to a ninth circuit decision issued weeks later. In Lorenzen v. Taggart the court permitted the creditor to assert a good faith defense that its collection attempts were not a willful stay violation. The ninth circuit ruled that when a creditor attempts to collect from a debtor after issuance of the discharge, the creditor is not liable for civil contempt penalties or sanctions if the creditor held a subjective, good faith belief that its actions did not violate the debtor’s discharge injunction. However, the ninth circuit also found that the debtor’s actions fell within an exception to the rule prohibiting debt collection after discharge when a debtor voluntarily “re-enters the fray” of an ongoing litigation that began before the debtor filed bankruptcy.

These decisions represent a split between the first and ninth circuits regarding the applicability of the good faith defense when a creditor violates the “discharge injunction.”   Resolution of this conflict is critical to the proper administration of this provision of the Bankruptcy Code.

The appeals court denied a petition for rehearing in Taggart. Despite numerous amicus briefs urging rehearing submitted by legal professionals, law professors, bar associations, as well as a former judge, the circuit court was not persuaded. Debtor’s counsel in Taggart filed a petition for writ of certiorari (the losing party files a document with the Supreme Court asking them to review the decision of a lower court) to the Supreme Court. The question presented to the Supreme Court is whether, under the Bankruptcy Code, a creditor’s good faith belief that the discharge injunction does not apply precludes a finding of civil contempt.

The Banking law attorneys of Chuhak & Tecson will continue to follow and report on whether the Supreme Court grants certiorari and will inform of the developing impact on lenders and other creditors. Feel free to contact a Banking law attorney with any questions.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by: Michele K. Jaspan, Of Counsel and Michael L. Moskowitz, Of Counsel